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Thursday, September 5, 2013

The Physics of Wall Street

The book The Physics of Wall Street, by James Weatherall, is a fascinating account of the advances in understanding financial markets made by physicists. The book delves into the personal lives of physicists who made their fortunes on Wall Street and gives an overview in clear language how they made their money.

It’s possible to get something out of this book even if you don’t know much about the mathematical side of investing, but it is primarily for readers interested in advances in the math used by quants over the years to beat the market.

For example, the book explains the difference between normal and Cauchy distributions and the range of other stable distributions between these two. Benoit Mandelbrot showed that the pattern of investment returns are wilder than the normal distribution and are better modeled by more the complex distributions between normal and Cauchy.

Over time, each physicist had to come up with progressively better methods to beat other investors who quickly learn about past techniques. The description of fairly recent genetic algorithms should be enough to convince most investors that they are far out of their league in trying to beat the market. As Weatherall says, “there is still a place for sophisticated investors to profit. You just need to be the most sophisticated investor.”

I highly recommend this book to anyone with an interest in the mathematics of investing. Others may choose to take a pass.